By Sanjay Godhwani and Erik Nikodem
Determining the right commercial property coverage and carrier is more important than ever.
Insurers and clients alike suffer the consequences of instability in the property insurance marketplace. In an industry plagued by unexpected, high-severity catastrophic risks, frequent volatile cycles can wreak havoc on capacity and pricing. Much of this instability is due to a fundamental gap in the understanding of the intrinsic cost structure of property insurance.
As carriers, it is our responsibility to help brokers and customers understand the complex elements impacting price, from catastrophe models and engineering information, to capital requirements and the role of reinsurance. In order to reach the price adequacy that insurers need and the transparency customers demand, it is critical for all parties to take a closer look at property insurance's cost structures and drivers.
Armed with a more strategic and sustainable view of property insurance pricing, risk managers and brokers can better position themselves with insurers and achieve far more effective, long-term partnerships.
Ask the Right Questions
Significant disparities exist among carriers in the way property insurance is priced, leaving risk managers and brokers to navigate largely on their own. It is worthwhile to take a moment to understand the complex elements behind an insurance carrier's approach to underwriting and pricing, and ask probing questions.
How Does Your Insurance Carrier Utilize Catastrophe Models?
Catastrophe models play a considerable role in the management of property insurance. They are widely used and accepted across the industry.
Catastrophe model output includes key data points such as average annual loss (AAL), tail risk and standard deviation. Carriers use the model output along with reinsurance and capital costs, expenses and a profit element to develop a technical price. The industry uses technical price as a foundation for pricing the catastrophe portion of the premium. Carriers utilize this target at an individual risk level, as well as at a portfolio level, to manage the pricing of an overall book.
The models give carriers of all sizes a broader view of the elements that impact loss expectancy. With the addition of new data from events such as hurricanes Ike and Katrina, and most recently Superstorm Sandy, catastrophe models continue to improve and provide robust intelligence.
Discrepancies arise, however. It is important to understand that the models provide just one view, albeit an insightful one. To thoroughly evaluate a risk, carriers need to leverage model data alongside other client-specific risk information developed through engineering, occupancy and region-specific statistics.
A longstanding property carrier will have valuable loss experience from which to draw educated conclusions and engineering information specific to a risk. The engineering information can provide a more precise view of the risk and its potential performance in an event.
Consider also that the catastrophe models are not all encompassing. Models for some perils, including tornado, flood and hail, as examples, have not been widely event tested. Further, there is inherent variability between individual risk and portfolio level modeling; a carrier's experience in relation to model results may provide more conclusive perspective on your risk.
As an insurance buyer, you want to look for the correlation of several important indicators. How reliant is your carrier on the catastrophe models? Do loss experience, client-specific engineering information and limit deployed contribute to the examination of your risk? A healthy balance between industry and client risk characteristics will result in a more stable quote.
How Much Reinsurance is Your Insurance Carrier Buying?
The role of reinsurance is pivotal; nearly all insurance carriers rely on reinsurance to provide some degree of the capacity they offer. The nature and structure of a carrier's reinsurance treaty can substantially affect the price and stability of your insurance program.
Reinsurance coverage is an important component of a carrier's capital structure; reinsurance helps stabilize loss experience, limiting liability on specific risks and protecting against catastrophes. The amounts, negotiations and structures of the treaties vary greatly between companies.
Transferring risk to reinsurers can be expensive. The cost of reinsurance can be much larger than the actuarially derived price of the risk transferred. In an effort to effectively reduce volatility and earnings fluctuations, some carriers must bear the burden of reinsurance costs.
Further, reinsurance companies take on significant long-tail risks all over the world. They are highly susceptible to the effects of a single event. A catastrophic event in one location can have a ripple effect that influences what that reinsurer may be willing to provide in another market. A sudden change in reinsurance arrangements -- or a reinsurer's financial condition -- can force a carrier to withdraw from a market, tighten terms and conditions, or non-renew policies. When a carrier's underwriting strategy is closely tied to its reinsurance arrangements, it can artificially boost risk appetite, positioning a carrier to cover a risk it may not otherwise be prepared to address adequately.
You, therefore, need to know how reliant your carrier is on reinsurance. A heavy reliance is a red flag and not only because of its impact on price. A reinsurer can become a second influence in the relationship you have with your carrier. Your carrier may not be in complete control of its capacity or pricing, or even the settlement of claims. So what happens when this second party changes its position?
What's Your Carrier's Capital Adequacy?
Understanding your insurance carrier's capital adequacy is the most important buying consideration of all. A carrier's capital adequacy will directly impact its ability to pay claims, which after all, is the most fundamental reason for purchasing insurance.
Further, the appropriate capital surplus enables an insurer to sustain relatively stable premiums in years following large catastrophic events. A business strategy of steady growth and premium stability is a good indication of responsible, long-term property insurance management.
Key determining questions include: Does the insurance carrier have a reputation for being able to settle claims promptly? How long has the carrier been writing property insurance? In the most recent events, what was the size of the carrier's loss in relation to its surplus position and was it forced to (or able to) raise capital after the event to stay in business? Have there been large fluctuations in its premium history?
There will always be significant disparities in underwriting and business philosophy among carriers that contribute to market fluctuations.
So ask probing questions. A particularly volatile loss history, a recent reinsurance treaty or new capital strains could all be influencing the price of your insurance program today, and its sustainability in the future. Your broker should be equipped to help you navigate these uncertainties.
Sanjay Godhwani (left) is President, Latin America and the Caribbean, AIG Property Casualty. Erik Nikodem is Property Executive, U.S. and Canada Region, AIG Property Casualty.
March 1, 2013
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